Elon Musk never fails to surprise. No, I’m not talking about him buying Twitter. I’m talking about how he bought Twitter. He has made himself the first walking, talking LBO.

What do I mean? While everyone focuses on how much debt he put on Twitter (a lot…the interest will likely exceed its cash flow), the bigger issue is how much debt he put on himself.

He has effectively engineered the first human LBO. He has found ways to put more leverage on himself than normally possible to allow him to buy a giant company. And he didn’t even have to raise his initial bid!

The big question is, what happens if he can’t service the debt? Would Elon defaulting be a systemic risk to markets? I think the answer is likely yes. That means Elon has made himself the first human who is too big to fail!

LBO Elon

What do I mean when I call Elon a walking LBO? LBOs finance acquisitions with large amounts of debt. This works well for predictable businesses with steady cash flows. It doesn’t work so well for unpredictable businesses that can crash and burn if the environment worsens. There is no margin of safety for negative surprises.

The issue isn’t just that Elon is buying Twitter largely with debt. It’s that he already has so much debt even before Twitter. Let’s review some of the numbers.

Per Reuters, Elon had already pledged $88B of Tesla to fund other deals and his personal spending (Elon calls himself “cash poor”). He has pledged an additional $62.5B for Twitter (more on that math in a minute) bringing the total to $150B. This is at least 2/3 of his total Tesla shares (likely greater after he sells shares to raise the $21B cash he promised Twitter).

Think about what happens if Tesla shares decline too much? We’ll come back to that in a bit too. The takeaway is Elon has borrowed against the majority of his net worth to fund more spending. That is the LBO aspect of this.

The difference is he doesn’t have predictable cash flows. In fact, he doesn’t have any cash flows. He can only raise money by selling Tesla stock (or inventing a new business if you’re bullish on The Boring Company).

So he has a lot of debt but no ability to service it! Normally, you can’t LBO something like that, but, hey, it’s Elon!

Before we get to how this all crumbles down, I want to circle back to the Twitter borrowing. While it is reported that he is borrowing $12.5B against his Twitter shares, the less discussed part is he had to collateralize 5X that (so $62.5B) to get the $12.5B from the banks.

Furthermore, per the Reuters story, if that $62.5B goes down 40% ($25B), the loan can get called. Presumably, the other $88B has similar terms, though perhaps a little more generous.

Also, don’t forget, cash poor Elon has to pay the interest on all this. That will require selling some shares as well.

How It Fails

I mean hopefully you’ve figured this out by now: Tesla stock declines 40% and Elon gets a margin call.

This leads to two problems. First, Elon could choose to offer to put up more Tesla stock as collateral. However, he may view this as throwing good money after bad. It also may be fruitless because of our second problem.

Shorts would gang up on Tesla and try to drive it down to force the margin call. Heck, they already tried this a number of years ago during the Solar City episode. Now, they would have more ammunition because Elon would be in more dire straits.

Even if he did put up more collateral, the shorts could try to force the stock to the level of the new margin call. It really does become a giant game of chicken and, given that Elon has already pledged so much of his stock, he’d have little ammunition to fire back with. He’d basically be pleading for the Wall Street Bets crowd to finally create their “mother of all short squeezes” to help him out.

For those of you with long memories, you’ll recall one of the things that really accelerated the financial crisis was when banks would raise capital, people would cover their shorts for a day, and the next day the shorts would take the stock down again to force another capital raise. This could be Tesla.

Systemic Risk

So let’s play this out. Elon gets backed into a corner with margin calls. What happens elsewhere?

First, there’s Twitter. it would likely default on its debt which would hurt the banks that have agreed to these new loans.

Second, while Tesla’s operations in theory would be unimpacted by its stock declining 50% or more, Tesla may have provisions in their debt or other operating contracts that are tied to its enterprise value. More importantly, Elon could lose control of the company if most of his stock is being sold or even be forced out. Certainly, there would be a major distraction that could possibly impact sales or production capacity.

Third, Tesla is a big holding for a lot of investment firms. Could some hedge funds collapse? Sure, why not? This would cause prime brokerage losses at their investment banks. Perhaps the same banks now lending to Elon’s Twitter bid.

Also consider how much option activity exists around Tesla. Some market maker will be short a boatload of puts. How much will they lose? How levered are they? Who are their counterparties?

It is not hard to imagine a trillion dollar company being cut in half causing substantial pain in markets, especially when it’s added to the giant declines in Netflix, Facebook, and others.

Speaking of which, the NASDAQ overall will likely suffer in sympathy. This will expose more levered bets that become losses. In other words, Elon won’t be the only one with a margin call. Elon’s margin call will spark margin calls for hedge funds, investment banks, Reddit day traders, etc.

It could be catastrophic.

Too Big To Fail

I can’t remember who made this point, but Fed hiking cycles may not always lead to recession but they do always cause a market panic. As Buffett would say, someone always gets caught swimming naked.

We have spent the last decade plus trying to fireproof banks from being too big to fail. But the next crisis is always the one you didn’t prepare for. What if the next too big to fail is Elon Musk?

Can policymakers allow one man’s excessive leverage to tank the markets? Or will they bail him out? I don’t even know what a bailout of an individual looks like, but perhaps the Fed would step in and buy Tesla stock at the price just above the next margin call?

You can say that sounds crazy but don’t forget how they bought junk bonds to prop up markets during Covid. The Fed has proven they will use any means necessary during a crisis.

If buying $10B of Tesla stock (they bought <$10B of junk bonds and it was enough to move markets) down say 50% prevents a market crisis (and the resulting economic contagion), do you really doubt this Fed would find a way to justify it?

There are so many aspects of this that are hard to imagine ahead of time. It’s very well possible there are even crazier scenarios than mine that could play out. There would certainly be a Congressional and SEC response about limiting use of margin, especially in concentrated positions.

But the real story here isn’t that the world’s richest man bought a social media company. No, it’s that the world’s richest man LBO’d himself and, in doing so, may have put the whole market at risk.

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